U.S. stocks not looking for synergy with gold, other assets

KateGibson

NEW YORK (MarketWatch) -- The correlations between asset classes and U.S. stocks fell dramatically in December, a bullish signal for near-term equity market performance, according to Nicholas Colas, chief market strategist at ConvergEx.

"The data from last month was a step in the right direction," said Colas, who added the reduced, but the still-existing correlation, remains worrisome.

The correlation between the SPDR Gold Trust
GLD, -0.89%
the largest gold exchange-traded fund, and the S&P 500 Index
SPX, +0.31%
as of Monday had fallen to 41% from 65% one month earlier.

'Gold is the hallmark asset class that is not supposed to move with stocks.'
Nicholas Colas, ConvergEx

During the same timeframe, the correlation between the Energy Select Sector SPDR ETF
XLE, -0.08%
and the S&P 500 declined to 86% from nearly 93%, and the Materials Select SPDR ETF
XLB, -0.35%
dropped to 85% from 95%.

In looking at the two months before the stock market began an extended rally from its early-March lows, the S&P 500 and the SPDR Gold Trust were pulling in opposite directions.

From Jan. 6 to March 6, 2009, the S&P 500 fell nearly 27%, while the SPDR Gold Trust rose 8.4%.

The stock market then began its bull run, with the S&P 500 climbing out of the red and finishing 19% higher by the end of the year, a timeframe that had the SPDR Gold Trust rising 16%.

"The weirdest thing about the stock market's rally was that gold was so highly correlated," said Colas, who adds that typically there is zero correlation between stocks and the precious metal.

"In business school, one of the first things you learn is gold is the hallmark asset class that is not supposed to move with stocks," the analyst said.

Bulls and Bears

Both a bullish and bearish case can be made for that atypical scenario, Colas noted.

One could argue that the global economic recovery has sparked demand for assets at large. "The bear side is it's just the Fed pumping in liquidity, which was then spread around like peanut butter," Colas said.

Just how much different asset classes move in concert with or diverge from domestic stocks is a critical driver of how much capital investors can dedicate to different risk assets.

"The lower the correlation, the easier it is to reduce risk," said Colas, who likens it to a don't-put-all-your-eggs-in-one-basket theory of investing.

"When correlations rise, the effect is one basket, even if the assets you own are seemingly different. When correlations fall, the different baskets work as they should, shielding a diversified portfolio from excess volatility."

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